Analysis of current economic conditions and policy

Representative Ryan on Conditional Macroeconomic Prediction

“Usually when we have a deep recession in America, we come bounding out of it with fast economic growth and job creation. We did that after the ’81/’82 recession with Ronald Reagan. We did that after the tough 70’s recession we had,” he tells the “Piers Morgan Tonight” host. “We’re limping out of this recession right now. Economic growth is stagnant. Job creation is stagnant. The labor force participation rate is stagnant.”

Representative Ryan and the Heritage Foundation have in the past demonstrated a belief in out-of-consensus (to say the least) macroeconomic behavioral relations [3][4], so it is not surprising that he has a uncertain grasp of macroeconomic prediction and conditioning. In this quote, like Ed Lazear, Representative Ryan does conditional analysis, but conditions only on depth of recession. He doesn’t condition on the source of the downturn – a sharp monetary disinflation in the 1980’s, and a financial crisis/housing bust/balance sheet recession in the most recent. What do formal cross section statistical analyses indicate about post-crisis output paths? From the IMF’s Article IV: Selected Issues report on the US:

…The economic recovery from the Great Recession has been sluggish by most standards, in particular considering the depth of the output loss during the crisis.
Whether U.S. output will eventually return to its pre-recession trend or remain on a permanently lower trajectory has important implications for policymaking. A number of research papers have documented that output remains below its pre-recession trend following financial crises, including IMF (2009), Reinhart and Rogoff (2009), and Cerra and Saxena
(2008). By contrast, Papell and Prodan (2011) find that GDP tends to return to its pre-crisis trend, but only after a long period (an average of nine years). …
Under all estimates of trend, we find that in the aftermath of advanced economies’ banking crises, per-capita output typically lags behind trend for at least 10 years after the crisis (Figure 5). Estimated output losses vary depending on the definition of trend but remain large, with the average 10-year loss in a range of 15.6 percent to 24.4 percent. Moreover, in the 7 cases for which it is possible to observe real GDP per capita for 20-years following the onset of the crisis, in only three instances—after the 1991 Sweden and Norway crises and the 1973 United Kingdom crisis—does real per-capita output rise above any of the six trend definitions at any point along the 20-year horizon.

The full sample results is shown in Figures 2 and 4 respectively from the IMF study:

These graphs confirm that recoveries are significantly weak after financial crises. The paper also notes that recessions are deeper after financial crises — so conditioning on a deep recession without conditioning on the common correlate will necessarily lead to fallacious conclusions, either accidentally, or deliberately.

Since the sample used in the IMF analysis is relatively small, one might wonder about the statistical significance. I turn to a study by Oscar Jorda, Moritz Schularick, and Alan Taylor , who examine 200 episodes over the 1870-2008 period. They focus on the difference in recoveries based upon credit intensities in the buildup (I am hopeful that Representative Ryan agrees there was a lot of debt built up in the run-up to the 2007-2009 recession):

During normal recessions, 10% excess leverage is associated with a further one percent decline in output from norm at the start of the recession but this effect is relatively short lived. During financial crisis recessions, the same amount of leverage generates a decline that is twice as large, nearing two percent, and its effect is felt over many years (except for a mild recovery in the third year). Two to three years into the recovery output remains depressed by an extra one percent.
The effect on consumption is similar overall but with some intriguing differences. The decline in consumption during a normal recession is larger than the decline in output, in fact nearing two percent. However, consumption recovers strongly the year after and the effects of leverage die out perhaps even more quickly than they did with output. In contrast, during financial crisis recessions consumption appears to follow a similar pattern to output, the effect seemingly disappearing by year three but then returning with a decline for years four-to-six that is on a par with or even higher than the decline in output.

The red line is the impact of leverage in the wake of a normal recession, and the blue line the impact in the wake of a financial recession.

But I expect Representative Ryan to take these findings into account at the same time he disavows his belief in the Heritage CDA “scoring” of his roadmap [5], and his fears of imminent hyperinflation. [6]

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I have to disagree. Not with the substance, but because this kind of distortion is entirely normal in politics. You always paint the other guy as doing badly. I have no problem with that.
This kind of distortion is not the same as accusing the other guy of cutting Medicare when your plan does the same cutting only worse. That’s a blunt lie. It’s not the same as hiding what you plan for Medicare, because that kind of misleading abandons the principles of small d democracy in favor of propaganda like that advanced by evil regimes.
But to complain about the pace of recovery is normal politics.

To complain about the pace of recover may be normal politics, but to misunderstand how the economy works still suggests an inability to govern wisely, and perhaps a deficit in understanding overall.
I’m also not sure we want to hold people who want to be our leaders to a lower standard than we hold our grade-school aged children. Just because politicians routinely lie does not mean we should shrug and let it pass.

“But to complain about the pace of recovery is normal politics.”
And to push back against those complaints is “Normal Politics”
Some have said complaints have moved over into lying territory.
When the complaints are in lying territory the “push back” should be ferocious.
In a political gun fight unilateral disarmament is foolish. Democrats usually bring a cream pie to a political gun fight.
YMMV

What that research shows is that in the past, recoveries following financial crises has been slower than those that follow from ordinary recessions. But that doesn’t mean we cannot (could not have) recovered faster from the latest crisis. Haven’t we learned anything from those prior crises regarding why the recoveries were slow? Can’t we do something different now to speed up the recovery? Where’s the American ingenuity?

@ Rich Berger
I am so glad that you finally brought the Romer/Bernstein projection up (which somehow became an Obama “promise” and then morphed into a “guarantee”)
Why not include this from the first page of the report?:
“A key goal enunciated by the President-Elect concerning the American Recovery and Reinvestment Plan is that it should save or create at least 3 million jobs by the end of 2010. For this reason, we have undertaken a preliminary analysis of the jobs effects of some of the prototypical recovery packages being discussed. Our analysis will surely evolve as we and other economists work further on this topic. The results will also change as the actual package parameters are determined in cooperation with the Congress.”
You see Rich you have to include the WHOLE study not just one graph. As usual, your commentary is flawed. There was no prediction, there was no promise, and there was no guarantee. Please be a good sport and admit your error.

I agree with Rich Berger. All the verbiage can’t obscure that Ryan’s claim is correct.
We weren’t hearing any claims from the Obama Administration to the contrary back in 2009. Their promises were to keep the recession from getting worse if they got their stimulus. Which they did.

Dr. Morbius-
The link also included a link to the full report. This is how the stimulus was sold and voila – epic failure. And I didn’t pile on by citing other graphs showing how weak this recovery has been compared to all others (except for the Depression, which also featured massive government intervention – a coincidence?)
Really, your contortions in trying to spin this are silly.

Rich-
And don’t forget the president’s own projects in the 2010 budget. See table 12-1 here. Unemployment was expected to be 5.6 percent by now. This game that Menzie plays of “critic if you’re red and ignore if you’re blue” is tiresome, especially when presented under the facade of thoughtful analysis.

Also, if you want to give Reagan’s policy credit for the growth after 81 recession, you have to take into consideration the recovery from the 79 recession. It was very strong. Real GDP grew 7.6% in Q4 1980 and 8.2% in Q1 1981.

Rich Berger Romer and Bernstein almost certainly knew that it was a balance sheet and recovery would be relatively slow. But there are deep balance sheet recessions (such as this one) and shallow balance sheet recessions (such as the 2001 recession). The Romer and Bernstein report was written in Nov/Dec 2008 using data that dramatically understated the economy’s steep descent. I think they expected the recession to resemble the 2001 recession because the initial data resembled that recession. And of course the stimulus package that was ultimately passed did not follow the stimulus package that Romer and Bernstein proposed. Remember, their paper assumed fiscal multipliers from tax cuts less than 1.00. All of the fiscal punch came from the spending multipliers. After the White House neutered the Romer and Bernstein plan the GOP politicians applied their economic geniuses to the problem. In the end the ARRA produced what was projected and what Obama promised. We got the job numbers they projected. The problem is that the promise was too small relative to the problem.
But nice try and thanks for playing.

An aside – Bernanke:“The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.”
Tomorrow’s jobs report will probably be ok. However, the global economy is beginning to teeter.
Not placing any blame here, just pointing out that FED action to lower mortgage and long term treasury rates will do little to reverse the approaching global slowdown.
Tax revenue will fall, regardless of marginal rates, and soverign deficits will widen.
The end game approaches.
Deficit increasing stimulus packages will not be able to bridge the gap to the other side of the valley. They will only deepen the hole from which we must climb.
Austerity will be a losing proposition due to recession, likewise for tax hikes.
The era of debt financed prosperity is drawing to a close.

I’m repeatedly amazed that our economy is this resilient. Europe is largely in recession. The stories out of Asia are kind of scary: vast amounts of product piling up that can’t be shipped or sold because there is no demand overseas. China continues to invest, invest, invest but it seems largely in ways that don’t stoke domestic demand, though they appear to be supporting domestic loan demand again. (You can’t enrich a country that much in a span of a few years.)
And yet the American economy keeps growing. Take out the contraction in public employment and this recovery has been pretty darned good overall. I didn’t expect this. There will be many, many papers published about this anomaly, each arguing a perspective, each allowing some group to claim yes or no depending on political need.

While this tepid recovery continues to defy logic e.g. that the US is not back in recession, who contemplates the counter-factual defined by no QE stimulus?
Put simply, where would we be without QE2?
That question is answered by Japan’s experience during the final blow-off from the 2000 tech bubble inversion. Look how far the N225 fell from the 2000 peak to the 2002 floor. That catastrophe — wherein Japan pulled back its QE program thinking the problem was solved — was most assuredly a fate awaiting the US economy. Up until the famous August 2010 JH QE2 speech the US economy was fast approaching stall speed and needed fresh stimulus to prevent an imminent crash.
Could one be so bold to suggest the current, pre-election economy would be much worse off without QE2?! (Coinciding with much higher unemployment and equities trading at discounts unseen in the West — ultimately forcing the Fed into BOJ-style equity purchases…!)
The Austerians consider a stimulus-free macro-economy more sustainable than a gov’t boosted (larded?) crony bailout bonanza. Philosophically, that sounds correct… But, Hey! Who can function when the economic zombie apocalypse is raging sublime (a la Burke) eviscerating demand and crippling the individual’s expectations in a stagnating pool of deflating assets…?
Will we need more QE in order to avoid the natural regression to the mean or can we subsist on a diet of economic candy until the real nutrients are put in place — investment credits for innovation leading to domestic job creation?
The counterfactual circumstance where no QE2 was propounded during the crisis in 2010 would have surely put the US and world economies at their low points this election year. Sure, a possible recovery from those putative lows would have manifested in 2013, but not without significant turmoil — more than even Honey Boo-Boo could fathom.
As for future QE… well, the cat is out of the bag and the Fed continues to modulate the markets — in hopes of doing the opposite!
Yes, it is a mess. But imagine how much messier it will be when the fiscal boogey-man is about to mean regress in a big way under president Romney!
Oh, unless we can be blackmailed into a GOP sweep where the rich take the levers of power giving war and famine policy primacy. Almost like now… but not quite.

“A number of research papers have documented that output remains below its pre-recession trend following financial crises, including IMF (2009), Reinhart and Rogoff (2009), and Cerra and Saxena (2008). By contrast, Papell and Prodan (2011) find that GDP tends to return to its pre-crisis trend, but only after a long period (an average of nine years). …”
Everyone one of these papers is ex-post. If these guys are so smart, where were the papers ex-ante? The sobering truth is that the economics profession was largely clueless about what was coming, and that’s why Romer et al were so willing to make rosy predictions about the future. Indeed, the President’s 2013 budget still makes rosy predictions about the future, with NGPD rising at an average 4.8% to 2022. Is that right? Are we now off the low growth trajectory? Has something changed? If so, what and why?
Had the President said, in his 2009 inaugural speech, that growth would remain low and unemployment high, and that’s the best we could realistically hope for, then he’d be in better shape now! He could say, “Look, I told you things would be bad, and they are.” But then there’s another sentence after that, which is “And I’d like to discuss how countries emerge after crises like this, the policies required, and what that means for all of us in terms of both obligations and opportunities.”
But the economics profession is still behind the curve! If you believe that low growth was pre-ordained, then you should have developed a pretty good road map for where we go from here. And who has that road map? Do you have one, Menzie? Because the President could sure as hell use one.

Romer and Bernstein were acting on the belief that 4th quarter GDP was expected to drop about 4%. Instead, it dropped by about 9%, our worst quarter post-WWII. Their great weakness was in forecasting.
Steve

2slugbaits “Thanks for playing” comment to Rich Berger reminds me that it is time for another round of “Name that Economist.”
For those who haven’t played before, let me explain the simple rules. I’ll give three clues that are quotes. The first to “name that economist” wins.
The contestants are 2slugbaits, Menzie, and Rich Berger. I’m your host Rick Stryker.
Here’s the first quote:
“But, a key fact is that recessions are followed by rebounds. Indeed, if periods of lower-than-normal growth were not followed by periods of higher-than-normal growth, the unemployment rate would never return to normal.”
Menzie has hit the buzzer.
Menzie: “Lazear.”
Rick Stryker: “Sorry Menzie, that sounds like Lazear it’s true but Lazear is incorrect. Anybody else want to try? 2Slugbaits?”
2Slugbaits: “Mitt Romney”
Rick Styker: “Sorry 2slugbaits, good guess but that’s incorrect. Ok, on to the next clue:”
“Another key fact is that deeper recessions are typically followed by more rapid growth.
Table 2 shows the peak-to-trough decline in real GDP in each of the last 10 recessions,
along with the average growth rate (at annual rates) in the 8 quarters following each recession.
The table shows that the three largest postwar recessions (1957-58, 1974-75, and 1981-82) were all followed by rapid growth over the two years after the trough in GDP.”
Rick Stryker: “Menzie and 2slugbaits both hit their buzzers.”
Menzie: “The speaker has an obviously uncertain grasp of macroeconomic prediction and conditioning. The answer must by Paul Ryan since the speaker is not conditioning on the source of the downturn.”
Rick Stryker: “Good try Menzie. That quote does sound exactly like Paul Ryan but that’s not the correct answer. 2Slugbaits?”
2Slugbaits: “American Enterprise Institute?”
Rick Stryker: “Nope but sure could have come from them. Let’s move to the final clue”
“Thus, it is very likely that this recession, which appears to be on track to be more severe than average, will be followed by a period when growth is well above its usual level.”
Menzie and 2slugbaits hit their buzzers.
Menzie: “It’s obviously Ed Lazear.”
Rick Stryker: “Sorry Menzie but we’ve already revealed that Lazear is not correct. You seem to be a bit obsessed with Lazear you know. 2slugbaits?”
2slugbaits: “I’ve got it. Hubbard, Mankiw, Taylor, and Hasset in ‘The Romney Plan for Economic Recovery, Growth, and Jobs'”
Rick Stryker: “Very good try 2slugbaits. Those authors did indeed make a point very similar to the second clue. But unfortunately that’s incorrect. Rick Berger, we haven’t heard from you yet. Care to try?”
Rich Berger: “This is crazy. I’ve already pointed out in a previous post that the answer is Romer and Bernstein. I just wanted to see how long this
would go on.”
Menzie: “That’s ridiculous and economically illiterate. There’s oodles and oodles of cross sectional evidence against that view and Romer and Bernstein know that.”
2slugbaits: “That’s absurd. Romer and Bernstein knew that we had a balance sheet recession and recovery would be slow”
Rick Stryker: “Congratulations Rich Berger, you’re a winner. Those quotes were indeed taken from ‘Notes Projections and the Budget Outlook’ issued by the CEA on Feb 28, 2009 available here: http://www.whitehouse.gov/administration/eop/cea/Economic-Projections-and-the-Budget-Outlook/”
Rick Stryker: “It seems that Romer and Bernstein were apparently for Ryan and Lazear before they were against them. Well, that’s it for another episode of “Name That Economist. Hope to see you next time.”

Rick Stryker Thanks. I’m flattered.tjsoverign deficits will widen.
Which is another way of saying that private balance sheets will improve.Rich Bergerthose are annualized numbers
Yes. So what’s your point? It’s a rate of change. The rate of descent was very steep. Many of the key economic variables were falling every bit as steep as anything we saw during the Great Depression. Look at the Baltic Dry Index to get a sense of how fast the global economy was falling.
What would the economy have done if noted economic genius Rich Berger had been McCain’s chief economnic adviser? Liquidate! Liquidate! Liquidate! More purgings! More pain! Cut spending! Cut taxes for the rich! In short, “double down on trickle down.”

2slugsWhich is another way of saying that private balance sheets will improve.
Have private balance sheets improved in Greece, Portugal, Spain, etc? I am not sure what your point is, unless you are referring to some identity that ignores growth, or negative growth.

tj The other day Krugman had an interesting graph using FRED data. It showed the ratio of household liabilities to GDP. The ratio has fallen almost 15 percent since the start of the recession. Households are repairing balance sheets, which means they must find some one or some entity that is willing to borrow. You cannot have saving without a counterpartty to borrow that saving. Normally household saving would go towards private sector investments, but corporations are sitting on cash. The only borrower of last resort is the government. Households cannot repair their balance sheets unless the government is willing to run deficits to absorb desired saving. If that doesn’t happen, then income must shrink.
I would hope you understand why your comment about Greece, Portugal and Spain is irrelevant to what I am arguing.

Here is an analysis a friend sent me. If Menzie using the right start date?Budgets do not come from the White House. They come from Congress – each for a “fiscal year” which begins on October 1 and runs until September 30 of the next year.The party that controlled Congress since January 2007 was the Democratic Party. It controlled the budgets for fiscal years 2008, 2009, 2010, and 2011.In their first year in control of Congress, 2007, they had to contend with George Bush for the 2008 budget, which caused them to compromise on spending, leading to a $458 billion deficit.However, for 2009 Nancy Pelosi and Harry Reid bypassed George Bush entirely, passing continuing resolutions instead of a budget, keeping government running until Barack Obama could take office. Then they passed a massive omnibus spending bill to complete the fiscal 2009 budget.And where was Barack Obama during this time? He was a member of that very Congress that passed massive spending bills for fiscal 2008-2009. He then later signed the omnibus bill, as President, to complete fiscal 2009.If the Democrats inherited any deficit, it was the fiscal 2007 deficit, the last of the Bush-Republican-Congress budgets. That deficit was the lowest in five years, $160 billion, and the fourth straight annual decline in deficit spending.After fiscal 2007, Democrats in Congress took control of spending – and that included Barack Obama in the Senate 2007-2008, who voted for these budgets.If Obama inherited any deficits, he inherited them from himself. In a nutshell, what Obama is saying is “I inherited a deficit that I voted for and then I expanded the average annual deficit four-fold since I became President.”

Ricardo: I think what you say makes an argument for starting the clock at 2009Q3, as the end of the last FY set up by G.W. Bush. That would mean 2012Q2 GDP per capita is 3.4% above where it was at 09Q3.

2slugsThe only borrower of last resort is the government. Households cannot repair their balance sheets unless the government is willing to run deficits to absorb desired saving.
The bottom line is that there is a mismatch between private sector savings and government borrowing in terms of the types of securities/assets demanded by the private sector and supplied by the public sector. Perhaps this explains why government borrowing is ending up as excess reserves in the private sector banking system and as assets at the FED.
The FED soaks up the government securities that the private sector does not want. All the private sector is doing is paying off debt, so there actually is very little increase in demand for loanable funds by HH’s. There is simply excess supply of government borrowing that has to go somewhere so it ends up as excess reserves, or in money market funds, or in foreign central banks.

Menzie,
What do you not understand about:“Budgets do not come from the White House. They come from Congress – each for a “fiscal year” which begins on October 1 and runs until September 30 of the next year.The party that controlled Congress since January 2007 was the Democratic Party. It controlled the budgets for fiscal years 2008, 2009, 2010, and 2011.”
The best Bush could have done was veto the bills but using continuing resoultion that would have allowed the Democrats to shut down government and blame Bush – oh, that’s right, they are doing that anyway. Damned if you do; damned if you don’t!